3 Steps to Pick a Value Stock
Hi again!
Hope everyone had a great start to the year! I certainly did because I started Investing Always to share and educate everyone about investment and personal finance =) For those who have been reading Investing Always or have read the free eGuide, you would know that one of my aim is to share ideas and knowledge based on what you need and not what I believe you may need.
Therefore, I am bringing forward a series on selecting value stocks for you! My original plan was to publish this after I have gone through the investing psychology to be a successful investor. However, the market has been very “generous” and throwing out deals for retail investors like you and I. In addition, some readers have also asked me how to take advantage of the current market too.
What about Investing Psychology?
Now, before fellow value investors throw eggs at me, I must clarify that investing psychology is still the most important aspect of value investing. However, timing is everything in investing. If you know when to invest, you will still be rewarded handsomely even if you are not good at investing. So I decided to bring forward and share the basic steps of selecting value stocks in the market, and make sure you are ready to capitalise on the current market in early 2016. I will talk more about investing psychology in the future, I promise.
In the next few weeks, I will be sharing in details how to select value stocks. Now at this point, I must emphasise that this process is only useful for value stock, it will not help to identify income, growth or penny stock so do bear that in mind when you are reading this.
Investing is like Shopping
I love analogies so to bring value investing closer to daily life, I will use an analogy to describe the process of selecting value stocks. This analogy has guided me well when I’m selecting value stocks, and I believe you will find it useful too!
Think of selecting value stocks like shopping for clothes, shoes, bags or whatever it may be, the concept is universal.
There are 3 basic steps that value investors and shoppers used in common. You may have seen it in different forms but all are based in the aged old wisdom of “Who, What, When, Why, How”.
How to Select Value Stock
The 3 basic steps are:
Step 1: Understand the Company (What, Who)
Step 2: Check the Finances (What, Why)
Step 3: Find out the Value (When)
An important point to note is the sequence. This means you should avoid reversing or mixing up the steps. You will understand the rationale after we go through the steps. In this first article, I will give a brief introduction of each step and how do they fit into the process of selecting value stocks.
Step 1: Understand the Company
When you are shopping for a bag, you are interested in the kind of bag you are buying (the model, colour, brand). Similarly, when you are selecting a value stock, you want to find out what is the company business and who runs the company. This is crucial because you don’t want to be buying a lousy business or a company that is ran by a poor quality management. You want a business that has great potential and strong market advantage, supported by a competent management.
Step 2: Check the Finances
After you have decided on a particular bag, you will usually check for its top quality and look out for any defects. This is exactly what value investors look for in a value stock. Similarly, after you are satisfied with the company business, it is time to find out if the company has any problem with their finances. You want to make find out how is the company’s financial health and why is the company’s finances doing well or poorly. You want a business that has a strong financial health and good earning track record because their earnings will translate into business value.
Step 3: Find out the Value
This step is about finding out when to buy. Before you ask what is the relationship between value and timing, let me go back to analogy. After you have decided on a particular bag and checked that it is of good quality, you will finally check its price. Almost intuitively, you will compare the price to the real value of the bag. If the price is too high, you will most probably not buy it. Perhaps, wait for another time or maybe when there is a sale.
If you haven’t noticed, that’s the relationship between value and timing. When you know the value of the company’s stock, you will know when it is time to buy it – that is when the price is right! Nobody has ever made money from overpaying so you want to buy a good business at a good price.
These are the 3 basic steps to selecting value stock. Honestly, after investing for more than 5 years, I observed that most retail investors do not know of these steps, let alone carrying them out. So if you are able to carry out these 3 basic steps, you are definitely on your way to be a good investor.
Now, you should have an overall picture on selecting value stocks. The rest of the series will dive into the details of each step and guide you on how to select value stock. Stay tuned!
See you soon!
Investing Always,
Pete
